Should The UK Government Have Signed Up Energy Consumers To A 35 Year £16 Billion Contract ?

In October 2013 the UK government announced that it had reached agreement in principle with the French government-owned enterprise EDF, backed by the nuclear power station builder Areva, the China General Nuclear Corporation and the China National Nuclear Corporation, for the supply of up to two nuclear power stations, the first at Hinkley Point in Somerset. The effect of the proposed deal is that if EDF brings such a power station on line, it will receive a guaranteed price for the electricity it produces for 35 years.

The mechanism will be a ‘contract for difference’. A ‘strike price’ has been agreed at just under twice the current market price of electricity and index-linked. When the market price for electricity is below the strike price, EDF will receive the difference. If the market price goes above the strike price, EDF will have to pay back the difference. Differences are collectively paid by (or to) consumers through their electricity bills, through a system set up by last year’s Energy Act.

David Horwarth

The contract and associated agreements will also contain credit guarantees, guarantees about insurance and provisions under which the government will compensate the contractor if any future government changes the level of taxation on nuclear energy or changes the law in any way that affects the contractor’s costs. In addition, if the government causes one of the stations to close for any reason other than one related to ‘health, safety, security, environmental, transport or safeguards concerns’ the contractor will be able to require the government to buy it at a price that delivers the contractor’s expected equity return on the whole deal.

The capital value of the contract, £16 billion, is larger than any existing PFI or PPP contract. At 35 years plus the construction period, it is in the top ten of such contracts in terms of length. Is it a good deal? Since we have not seen all the terms, some because they are commercially sensitive and some because they have not been agreed yet, it is perhaps impossible to say with certainty. What is certain, however, is that the deal interferes with future parliaments’ freedom of action in energy policy, and it will probably do so without specific parliamentary consent. The Energy Act envisages that such contracts will be concluded before parliament gets to see their full terms.

[vision_pullquote style=”3″ align=””] What is certain, however, is that the deal interferes with future parliaments’ freedom of action in energy policy, and it will probably do so without specific parliamentary consent. [/vision_pullquote]

But all is not well. The government, as required by EU law, has asked the European Commission to rule that the proposed deal does not constitute illegal ‘state aid’ (subsidy). The Commission’s initial view is that the proposed contract raises serious concerns that require detailed investigation. The Commission is worried that the government’s claim that new nuclear power is necessary ‘to keep the lights on’ makes no sense since the new stations will not be ready until 2023 whereas the UK’s problems with continuity of supply will come to a head before 2020. Even worse from a legal point of view, the Commission calculates that the degree of support proposed vastly exceeds the cost of even the most extensive power outages that might happen during that time. In addition, the government’s own submissions reveal that it thinks that nuclear power will become commercially viable by 2027 anyway, so that the only benefit being secured is a four year acceleration of nuclear deployment.

The government argues that the support offered helps decarbonisation of the power sector and promotes affordability of electricity, but the Commission points out that the government’s own estimates of the future carbon price imply that before 2027 other methods of decarbonisation will be more efficient, and as for affordability, the proposed contract puts prices up, not down. The Commission also notes that EDF does not actually have to deliver any nuclear power stations. All the deal provides for is the price EDF will receive for electricity if it does deliver. As a consequence, it is hard to argue that the deal is imposing any sort of public service obligation on EDF. In addition, the length of contract seems to be related purely to financial considerations. Further problems include the failure of the deal to ensure that the rate of return is not excessive or that the costs of the project are the lowest obtainable. The form of the proposed credit guarantee is also a problem, because it protects holders of equity rather than taking effect only after equity has been wiped out.

The Commission will deliver its verdict towards the end of this year. But this is not the end of the proposed deal’s legal problems. At a recent workshop held by the Centre for Business Research at Cambridge University we gathered together experts in contract law, public law, EU law and international law to discuss some of the issues that are likely to arise if the new nuclear contract goes ahead in its present form. Our approach was to stress-test the contract by asking what would happen if political circumstances changed dramatically. What if, for example, a new green government came to power that wanted to carry out a Merkel-style U-turn on nuclear energy? Or, perhaps more realistically, what if the public turned against paying the contract price and a future government wanted to re-balance the deal?

[vision_pullquote style=”3″ align=”right”] At EU level the Court of Justice in Luxembourg seems to be on the cusp of declaring illegal all electricity support mechanisms that discriminate against cross-border generation. [/vision_pullquote]

A number of other legal flaws in the structure quickly came into focus. At EU level the Court of Justice in Luxembourg seems to be on the cusp of declaring illegal all electricity support mechanisms that discriminate against cross-border generation, so that the whole basis of the deal, the Energy Act 2013, is under threat. The current government would seek to defend the new regime. A future government might not bother, and rest content with the possible legal consequence that all contracts for difference under it might count as completely void. At the level of domestic law, because EDF is under no obvious obligation, not even an obligation to supply a nuclear power station, a future government might say that no legally enforceable contract came into existence. That might not be a problem for that government, but it would be a very big problem for EDF. Even if the problem is fixed in advance, the degree to which the contract purports to constrain government is so great and continues over such a long period of time that the courts’ normal tolerance for ordinary commercial contracts that fetter the discretion of public authorities might be exhausted. If that happens, the contract might be declared void as contrary to public policy and EDF left with some very big stranded assets. (Should EDF feel aggrieved at these possibilities? Probably not, since the majority of them would be a direct result of EDF’s success in negotiating itself an extraordinarily good deal).

As a result we believe that it is likely that the contract will have to be renegotiated. Even if it survives the immediate state aid challenge, the risk that the legal basis of the contract might collapse at some time over the next 40 years is not one that has properly been taken into account. Each of the specific flaws we discussed might be patched over: the state aid problem might be solved by the government being more transparent about the deal’s benefits and costs, by more careful matching of environmental ends and financial means and by incorporating a process of competitive tendering; the free movement of goods problem might be met by allowing foreign generators into the contract-for-differences regime; the one-sided nature of the deal might be corrected for by using a more formal type of contract or by creating legally enforceable options; and the fettering discretion problem might be eased by capping the sums recoverable by the contractor in the event of changes in the law. But the real problem is that the contract is so long that no one knows what changes in the legal environment might happen in that time, just as no one can predict what will change in the political, economic and technological environment. Contracts of this length cannot provide for every contingency, especially not for legal contingencies that might alter the effect of the contract’s own provisions. The best they can do is lay down expectations of procedures for their own future renegotiation. This is not to say that contracts have no place in long term projects, but it is to say that recognition of their limitations as a form of legal engineering is the first step toward being able to use them properly.

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